Is it Time to Sell Canadian Bank Stocks?

Canada’s banks are some of the best companies in the country. They’re certainly the best banks in the world.

In fact, if you forced me to choose what I think is Canada’s best company, I’d probably choose Royal Bank (TSX:RY). It has a special combination of prudent management, conservative nature, and quality assets. My buddy Jim has about 20% of his net worth in Royal shares, and he sleeps very well at night. I think he’s onto something.

My opinion is probably one that a lot of you share; I’m hardly going out on a limb here. There are tons of reasons why investors like Canada’s six largest banks.

• They dominate the domestic banking world and each have foreign operations.

• Their riskiest mortgages are insured by a branch of the federal government (and the operation is ridiculously profitable for taxpayers, too), which takes away a lot of the bank’s risk.

• Banks have invested billions into tech, which has made the whole operation all the more efficient and profitable.

• And, if that’s not enough, banks have insurance, wealth management, capital markets, and other ancillary businesses that are counter cyclical to the main business — and that boost returns on equity at the same time.

In fact, as I explained in a recent edition of the podcast, my top five individual positions are dominated by Canada’s banks. I think they’re wonderful long-term wealth creators, and I bet at least a few of you agree with me, too.

Usually Canadian bank shares are steady performers, hardly ever leading the market. They go up and down like most stocks, but generally don’t get too excited in either direction. But the last few years have been an exception. Most big bank shares in Canada have steadily marched higher and to the right. The laggard has been TD Bank (TSX:TD), and it still put up a 68%+ total return in the last three years — and that was after it was fined billions as part of a massive money laundering scandal.

An equal-weighted bank portfolio bought exactly three years ago would be up 114.42%, or more than 35% per year.

This performance has caused some of you to ask me whether it’s time to start selling your bank stocks. Rather than answer these questions individually, I decided to put my thoughts into this post.

So allow me to present both the case to sell and the case not to, and I’ll tell y’all what I’m doing at the end. Let’s start with the contrarian opinion — why you should consider selling.

Why it’s time to sell

By now it should be pretty obvious how I choose stocks, but in case you haven’t been paying attention here’s what I’m looking for:

• Good companies

• That I understand

• Which are temporarily cheap

• With good balance sheets

• That pay steadily increasing dividends

I went into more detail about this a few weeks ago if you’re looking for the more detailed version.

When it comes to Canadian bank stocks, I’ve taken this strategy and simplified it even further. Here’s what I do:

• Wait until a Canadian bank makes a new 52-week low

• Buy it

• If more than one make a 52-week low either buy both or choose the highest quality one

This rule told me to buy CIBC (TSX:CM) shares in 2022, Royal Bank shares in 2023, TD Bank shares last year, and EQ Bank (TSX:EQB) shares a couple of months ago. It has been a ridiculously good strategy, and that’s why I use it.

But if such a strategy has been good at identifying buying opportunities, then shouldn’t it be fairly easy to identify selling opportunities using some sort of similar rule? Such a strategy could be implemented in a RRSP or TFSA, accounts where capital gains taxes are avoided, while any taxable accounts would embrace a more buy-and-hold approach.

One strategy could be to sell bank shares when they trade for close to 10-year valuation highs. If this were your strategy, then it’s kinda looking like it’s time to sell. For instance, CIBC is currently trading for 13.5x forward earnings. That’s CIBC’s highest P/E ratio in more than a decade, and about 35% overvalued based on the mean valuation.

Royal Bank is similarly overvalued. Shares trade at 14.7x next year’s earnings, while the mean is 11.8x. And so on; this persists throughout the Big Six.

You could also argue that the banks are overvalued when looking at their dividend yields. National Bank (TSX:NA) shares currently offer a 2.9% yield. That’s the bank’s lowest dividend yield in more than a decade, and more than 30% lower than the mean yield since 2013. If you subscribe to the dividend yield theory of valuation — which I generally find to be a quick and dirty way to come up with a stock’s fair value — then you’d argue that National Bank shares are about 30% undervalued.

You could then take your bank share profits and put them to work in some other undervalued dividend stock. It wouldn’t be that hard to surpass the 2.9% yield offered by both National and Royal Bank, and such a move would could yield more potential capital gains, too.

The case for not selling

Let’s start off with the obvious. Canadian banks have been wonderful long-term compounders and selling such a stock is generally a bad idea. Even if it seems a little bit overvalued.

Over the last 30 years, Royal Bank shares are up 9,149% if you reinvested dividends. That works out to a 16.06% annual return, which smoked the TSX Composite, S&P 500, and even the NASDAQ 100. That’s enough to turn a $10,000 initial investment into something worth $924,000.

Why bother trying to time something like that? Just sit back, relax, and let the compounding happen. Don’t try to galaxy brain this, just let a great company do its thing in the background and go hang out with your cat. Or, y’know, human companion.

That chart brings up another excellent reason why it’s probably not a good idea to try and sell. You’ll notice that shares have marched steadily higher for most of the last 30 years. For every 2008-09, or 2020, or 2023 buying opportunity, there were dozens and dozens of all-time highs. Imagine selling in 1996, or 2005, or whenever, content with your nice 3, 5, or 10-year investment, and then watching the stock continue to murder most other investments.

It would be even worse if such a move triggered a taxable event, and then the subsequent move didn’t work out. As much as I like my buy-good-companies-when-they’re-cheap strategy, it isn’t going to have a 100% success rate. Sometimes you’ll swing and sometimes you’ll miss.

In general, one thing I’ve found is introducing more decisions into your investment framework usually isn’t such a great idea. More decisions equals more opportunities to screw up. Think of it as a coin flip. Even if the odds are stacked in your favour, the more flips you introduce, the greater chance one or two will turn out badly.

Another argument against selling is analysts expect Canadian bank earnings to pick up over the next couple of years. Royal Bank announced a few weeks ago that in fiscal 2025 it generated $14.43 per share in normalized earnings. The bottom line is expected to then increase:

• 8.4% to $15.64 per share in 2026

• 9.8% to $17.16 per share in 2027

• 13.3% to $19.45 per share in 2028

Obviously, predicting earnings three years out is no exact science. A lot can happen between now and then, and analysts are notorious for screwing up both earnings and price targets. But, at the same time, these analysts aren’t pulling these numbers out of the sky. Investors expect bank earnings to continue climbing as headwinds like a weak Toronto real estate market and higher than usual loan loss provisions start to right themselves.

Besides, is paying 13.5x earnings for a stock expected to grow the bottom line by more than 10% per year really such a bad thing? Especially when the S&P 500 currently trades for more than 22x earnings? I’d argue that such a stock is actually cheap — or at least fairly valued. I’m not sure I’d sell.

What’s Nelly doing?

You guys probably know the answer, but I’m going to say it all dramatic like anyway.

I’m not selling my bank stocks. In fact, I plan to never sell. You’ll have to pry them out of my cold, dead hands.

But, at the same time, I’m sure not buying. I want to buy when these stocks are at 52-week lows, and most are nowhere close to those levels. EQ Bank is the only one not bumping up against fresh 52-week highs every week. I’m a fan of EQ — and a fan of the Loblaw deal — but I’m just not super excited after EQ shares moved up so aggressively.

If I miss out and EQ Bank shares rally sharply from here? Oh well. There are plenty of other cheap stocks out there. I’d rather spend my energy analyzing them, and then putting my dollars into the best opportunities. If I do it correctly I’ve diversified my portfolio, locked in a nice dividend yield, given my money the opportunity to grow, and given future Nelly an inflation-beating income stream.

Remember, those “overvalued” bank stocks are still paying me generous dividends. I bought a lot of Royal Bank in the $80-$90 range during 2020, and those shares are flirting with an 8% yield on cost. I’m happy to reinvest those dividends into cheaper stocks, or use them to create memories for my family. Why interrupt that?

If you’re losing sleep because you think your bank stocks are supremely overvalued, then perhaps it’s time to sell. I will never judge anyone for making an investment decision that improves their mental health. But absent that, I’m not sure selling a bank stock is a good idea. I know I’m sure not.

One last thing

This is the last Sunday edition of the newsletter until January 4th. Merry Christmas, Happy Holidays, and I’ll see everyone in 2026!

Your author has a position in Bank of Montreal, Bank of Nova Scotia, CIBC, EQ Bank, National Bank of Canada, Royal Bank, and TD Bank. His full portfolio is available for premium subscribers to view. Nothing you just read is investment advice. Consult a qualified financial professional before making any decisions.